Be Careful When Creating Intercreditor Agreements

 Posted on December 23, 2017 in Creditor's Rights

When a debtor borrows money from multiple creditors, an intercreditor agreement can be helpful in determining the rights of each creditor. The primary purpose of the agreement is to establish which creditor receives priority in case the borrower defaults on its debts. The higher-priority lender is called the senior creditor, and the other lender is called the junior creditor. In the event of default, the agreement may state that the senior creditor must be repaid in full before the junior creditor can take action on the debt. However, the agreement can also include provisions that will protect the junior creditor in case the senior creditor takes action that impairs the junior creditor's ability to collect on its debt. Depending on the severity of the action, a court can decide to strip the senior creditor of its priority claim on the debt.

Impairment

An intercreditor agreement is based on the junior creditor knowing how much the senior creditor must be repaid before the junior creditor can file a claim on the defaulted debt. Following the agreement, a senior creditor may act on its own to increase the borrower’s debt obligation by:

• Lending more money as part of the initial loan;
• Raising the interest rate; or
• Changing how soon the loan will reach maturity.

When the senior creditor increases the size of the debt, it makes it more difficult for the junior creditor to collect on its own debt. In some cases, a court may decide that the impairment is in violation of the agreement and grant senior status to the junior creditor.

Recent Case

The Illinois appellate court case of Bowling Green Sports Center v. GAG, LLC, concerned a senior creditor that violated the terms of an intercreditor agreement. The senior creditor had lent $3.4 million to the debtor, while the junior creditor had lent $405,000. The agreement included provisions that:

• The junior creditor cannot sue the borrower to recover its debt until the senior creditor has recovered its entire debt; and
• The senior creditor cannot modify the value of its loan without the junior creditor’s consent.

Months after the agreement was made, the senior creditor increased its loan by $51,000 without informing the junior creditor. When the junior creditor sued the debtor years later for breach of contract, the senior creditor intervened and claimed that the debtor still needed to repay its obligation to the senior creditor. The junior creditor countered that the senior creditor violated the agreement by increasing its loan without permission. The court ruled that the senior creditor did violate the agreement, but the violation was not substantial enough to take away its position as senior creditor. Instead, the court defined the $51,000 as a separate debt obligation that held less priority than the junior creditor’s loan.

Reaching Agreement

You must carefully consider which actions will be allowed and prohibited in an intercreditor agreement. A Chicago creditors’ rights attorney at Dimand Walinski Law Offices, P.C., can help you create a clear and comprehensive agreement. Schedule a consultation by calling 312-704-0771.

Source:

http://www.illinoiscourts.gov/OPINIONS/AppellateCourt/2017/2ndDistrict/2160656.pdf